What is Recession and How it comes? Causes and its Impacts

Basics of Economic Recession

To have a clear concept of the Recession, let us go step-by-step for a better understanding of every aspect of it. As the present economic crisis is because of the COVID-19 pandemic, it is also called the COVID-19 Recession, also referred to as the Great Lockdown. It is often addressed as the Recession of global reach.

Major Loss in the coming year, 2023:

The global output would have risen 23 percent since 2016 globally if the COVID-19 pandemic would not occur. Now, however, it is projected to grow only 17 percent. The global slowdown will leave real GDP still below its pre-pandemic trend and is expected to cost the world more than $17 trillion, which is nearly 20 percent of the world's income.

Russia, Indonesia, India, the UK, and Germany are among the countries that may contribute the most to this global output loss, according to the reports of the United Nations Conference on Trade and Development (UNCTAD).

Report said that while India will be bearing a loss of 7.8 percent in 2023, the Euroland is expected to lose 5.1 percent, China 5.7 percent, the U.K. 6.8 percent, and Russia may bear a 12.6 percent output loss. Rising interest rates, diminishing the value of currencies, and mounting public debt - all these factors aid in the hike in the price of foods and fuels - have introduced uncertainty in the global markets.

Global economic growth is declining as many countries fall into recession.

Mounting Public Debt:

The International Monetary Fund (IMF) has pointed to the possibility of a recession next year as well. IMF's MD, Kristalina Georgieva said earlier this week that the world economic growth may be lower by $4 trillion through 2026. Things are more likely to get worse before they get better, she added.

The impact of the Recession will be seen worldwide, but this economic crisis will be more faced by developing countries across the globe, many of which are edging closer to debt default. Lower-income and lower-middle-income countries are spending more money to service their public debt. Somalia, Sri Lanka, Angola, Gabon, and Laos are the countries with the highest proportion of revenue required to service their public debt. Such a situation of Recession is an alarm for the above-mentioned countries.

Diminishing Currencies

In an effort to cushion the enfeebled currencies, developing countries have spent nearly $379 billion of their reserves, which is nearly double the amount of new Special Drawing Rights (SDR) by the IMF. The value of an SDR is based on a basket of the world's five leading currencies: the US Dollar, Euro, Yuan, Yen, and the UK Pound.

Costly Food and Fuel

Food and energy are two factors that directly affect the lives of common people. The year 2022 has seen a drastic rise in food and fuel prices. While the food price index rose to a lifetime high of 125.7 in 2021 and further to 146.94 by September 2022, the Indian basket of crude oil prices averaged $102.14 a barrel from April-October 2022. The price of the Indian basket of crude oil was $79.18 a barrel in 2021-22 and $44.82 a barrel in the previous financial year.

Authentic Definitions of Recession

The economic condition of the country during the Recession is worse in every aspect. During a recession, the economy struggles, people lose work, companies make fewer sales, and the country's overall economic output declines. The point where the economy officially falls into a recession depends on a variety of factors.

In the year 1974, Economist Julius Shiskin came up with a few rules of thumb to define a recession: The most popular was two consecutive quarters of declining GDP. A healthy economy expands over time, so two quarters in a row of contracting output suggests there are serious underlying problems, according to Shiskin. This definition of a recession became a common standard over the years.

The Reserve Bank of India (RBI) is generally recognized as the authority that defines the starting and ending dates of Indian recessions. RBI has its own definition, "A Recession is widely regarded as a period of prolonged decline in output experienced across much of the economy. To be more concrete, commentators often consider a recession to be in progress when total output (real gross domestic product) has declined for at least two consecutive quarters."

The National Bureau of Economic Research (NBER) has its own definition of what constitutes a recession. It is "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

The NBER's definition is more flexible than Shiskin's rule for determining what is a recession. For instance, the coronavirus could potentially create a W-shaped recession, where the economy falls one quarter, starts to grow, then drops again in the future. This would not be a recession by Shiskin's rules but could be under the NBER's definition.

The Causes of Economic Recession

There are many possible ways that are causes of the Recession. The following phenomena act as the drivers of a Recession:

A Sudden Economic Shock: An economic shock is a surprise problem that creates serious financial damage. In the 1970s, OPEC doubled the oil prices without warning in India, causing an economic crisis. The coronavirus outbreak, commonly known as COVID -19, which shut down economies worldwide, is a more recent example of a sudden economic shock.

Excessive Debt

When individuals or businesses take on too much debt, the cost of servicing the debt can grow to the point where they can't pay their bills. Growing debt defaults and bankruptcies then capsize the economy. The housing bubble in the mid-aughts that led to the Great Recession is a prime example of excessive debt, further leading to a recession.

Asset Bubbles

When investing decisions are driven by emotion, bad economic outcomes aren't far behind, as investors can become too optimistic during a strong economy. Former Fed Chair Alan Greenspan famously referred to this tendency as "Irrational Exuberance," in describing the outsized gains in the stock market in the late 1990s. Irrational exuberance inflates stock market or real estate bubbles-and when the bubbles pop, panic selling can crash the market, causing a recession.

Too much Inflation

Basically, a general increase in prices and fall in the purchasing value of money is known as Inflation. It is said that Inflation works to be good, but excessive inflation is not good for the economic growth of the country. Hence, Inflation needs to be checked at regular intervals. Central banks control inflation by raising interest rates, and higher interest rates depress economic activity. Out-of-control inflation was an ongoing problem in the U.S. in the 1970s. To break the cycle, the Federal Reserve rapidly raised interest rates which caused a recession.

Too much Deflation

While runaway inflation can create a recession, deflation can be even worse. Deflation is the reduction of the general level of prices in an economy that causes wages to contract, which further depresses prices. When a deflationary feedback loop gets out of hand, people and business stop spending, which undermines the economy. Central banks and Economists have few tools to fix the underlying problems that cause deflation. Japan's struggles with deflation throughout most of the 1990s caused a severe recession.

Technological Change

New technological innovations increase productivity and help the economy of the country over the long term, but there can be short-term periods of adjustment to technological breakthroughs. In the 19th century, there were waves of labor-saving technological improvements. The Industrial Revolution made entire professions obsolete, sparking recessions and hard times. Today, some economists worry that AI and robots could cause recessions by eliminating whole categories of jobs.

Recession and the Business Cycle:

A Business Cycle is the periodic growth and decline of a nation's economy. Hence, the Business Cycle and Recession are interconnected. As the economic expansion ages, asset values rise more rapidly and debt loads become larger. At a certain point in the cycle, one of the phenomena from the list above derails economic expansion. The shock bursts asset bubbles crash the stock market and make those large debt loads too expensive to maintain. As a result, growth contracts and the economy enters recession.

Difference Between Recession and Depression

Recessions and depressions are an integral part of the Economic Cycle. These both are indispensable to each other. The cause of recession and Depression may have similar causes, but the overall impact of depression is much, much worse, compared to recession. There are huger job losses, higher unemployment, and steeper declines in GDP. Most of all, depression lasts longer-years, not months-and it takes more time for the economy to recover.
Economists do not have a set definition or fixed measurements to show what counts as a depression. Suffice it to say, all the impacts of depression are deeper and last longer. In the past century, India has faced just one depression: The Great Depression.

The Great Depression

The Great Depression started in 1929 and lasted in the year 1933. Although the economy didn't really recover until World War II, nearly a decade later. During the Great Depression, unemployment rose to 24.9% in 1933, and the GDP grew by 10.8% in 1934. It was the most unprecedented economic collapse in modern Indian history. If compared, the Great Recession was the worst recession since the Great Depression. During the Great Recession, unemployment peaked at around 10% and the recession officially lasted from December 2007 to June 2009, about a year and a half.
Some economists are afraid that the coronavirus recession could alter into a depression, depending on how long it lasts. Unemployment hit 14.7% in May 2020, which is the worst level seen since the depths of the Great Recession.

Indian Aspect of Recession

Indian CEOs are conscious of a decline in the growth of companies and the country but are anticipating to bounce back in the short-term, according to KPMG 2022 India CEO Outlook.

Eighty-six percent of CEOs in India; compared to 71 percent of CEOs globally, predict that the Recession will affect the company earnings by up to 10 percent for the coming year.

The top three steps to weather such challenges include reducing profit margins and managing costs - by 40 percent, boosting productivity and diversifying their supply chain by 34 percent, and implementing a hiring freeze by 33 percent.

Half of the Indian CEO, compared to 37 percent of CEOs globally, plan to pause or reduce their digital transformation strategy in the next six months to prepare for an anticipated recession.

How long do Recessions Last?

The RBI tracks the average length of Indian recessions. According to RBI data, India has gone through four recessions in 1958, 1966, 1973, and 1980 and the most recent; COVID-19 is said to be the fifth one.

India faced its first recession, known as Trade Balance in 1958 due to balance of payment problems. The primary sector of the economy, "agriculture" was facing its worst nightmare as its production was affected badly due to poor monsoon. Later, India imported around 60 lakh tonnes of food, which led to a drop in the economy and an increase in prices. The GDP went into negative 1.2% and the country faced skyrocketing import bills. The consequences were that the foreign reserves of India dropped to half.

India faced a recession post-China and Pakistan war in 1962 and 1965 respectively. The country later faced two terrible droughts that affected food grain production which dropped by around 20%. India depended on foreign aid and came to rescue the starving populace. 1 crore tons of food aid was received by the country. The GDP growth was negative 3.66%. It was the Dreadful Drought of 1966.

India went through an energy crisis due to the Organization of Arab Petroleum Exporting Countries (OAPEC), indicating an oil embargo which means a ban on oil trade. They attacked especially the countries that supported Israel during the ongoing war, "Yom Kippur". The oil prices rose high by around 400%, double the price of foreign exchange reserves present in India at that time. The GDP growth was negative 0.35%. This was called the Energy Emergency of 1973.

The oil breakdown of 1980 was another one. The world faced an oil shortage due to Iranian Revolution. It shocked the world and led to an increase in oil prices. It continued even after the Iran-Iraq war which fueled the prices more. The GDP growth was negative 5.2% and created a balance of payment crisis for India.

Affect of Recession for General Public:

During an economic crisis, Recession, there are varied effects. One can lose a job, unemployment keeps rising, and prices of daily-use commodities also get affected by the hike in price.

Investments in stocks, bonds, real estate, and other assets can lose money in a recession, reducing savings.

Entrepreneurs make fewer sales during a recession, and may even be forced into bankruptcy. The government tries to support businesses during these tough times, like with the Emergency Credit Line Guarantee Scheme, but it's hard to keep everyone afloat during a severe downturn.

As more people are unable to pay their bills during a recession, lenders tighten standards for mortgages, car loans, and other types of financing. You need a better credit score or a larger down payment to qualify for a loan which would be the case during more normal economic times.

Even if you plan ahead to prepare for a recession, it can be a frightening experience. If there's any silver lining, it's that recessions do not last forever. Even the Great Depression eventually ended, and when it did, it was followed by arguably the strongest period of economic growth in Indian history.